The UK authorised funds regime will have a new type of FCA authorised fund, the “long-term asset fund” or LTAF, which will invest mainly in long-term, illiquid assets, available from 15 November 2021. The purpose of the LTAF is to provide a UK authorised open-ended fund structure that enables investment in long-term, illiquid assets while offering appropriate structural safeguards. Long-term, illiquid assets include venture capital, private equity, private debt, real estate, and infrastructure.
The Financial Conduct Authority (FCA) consulted on draft rules for the LTAF earlier this year in its Consultation Paper 21/12 (CP 21/12), and the final rules have now been published in the FCA’s October Policy Statement PS21/14 (PS21/14).
The LTAF is the culmination of considerable work undertaken by the industry, regulators and government, including the work of the Investment Association (IA) which published its UK Funds Regime Working Group report (June 2019), including proposals for an LTAF as further developed in the IA’s LTAF position paper (July 2020). Since then, the FCA has been working with the IA and other stakeholders (including the Bank of England’s Working Group on Productive Finance) on developing the LTAF proposals, which have now been finalised as set out in PS21/14.
What is the LTAF?
As set out above the LTAF is a new type of open-ended FCA authorised investment fund the purpose of which must be to invest mainly in assets which are long-term and illiquid in nature.
The LTAF will be an open-ended fund. However, with a minimum notice period of 90 days to redeem and dealing allowed not more frequently than monthly (plus other permitted liquidity tools) the LTAF will look quite different to existing authorised funds.
The basis of the LTAF regime that the FCA proposed in CP 21/12 was strong governance and clear disclosure and the FCA has maintained this approach in the final rules set out in PS21/14.
The specific rules for the LTAF are contained in a new Chapter 15 of COLL. These rules are principles based to provide the framework for this new type of fund and allow a high level of investment flexibility. Taking account of the nature of the assets which the LTAF will hold there are certain additional requirements particularly on the manager and depositary. The LTAF will be an alternative investment fund (AIF) and hence FUND will apply, along with other rules derived from the alternative investment fund managers directive (AIFMD) as implemented in the UK, a number of which are specifically referenced in COLL, Chapter 15.
Other rules will also apply, including those set out in the COBS, PRIN and SYSC sourcebooks.
What are the investment and borrowing powers of the LTAF?
The investment and borrowing powers of the LTAF are based on the existing rules for the qualified investor scheme (QIS) but with certain differences, which we mention below.
The FCA rules for the LTAF provide that its investment strategy must be to invest mainly in assets which are long-term and illiquid in nature, or in other funds which invest in such assets. FCA guidance in relation to this high-level permissive rule is that the FCA would expect the strategy of the LTAF to be to invest at least 50 per cent of its assets in unlisted securities and other long-term assets such as interests in immovables or other funds investing in such assets. The guidance confirms that an LTAF could have a strategy of investing mainly in a mix of unlisted assets and listed but illiquid assets.
The manager of the LTAF will need to ensure, that taking account of the investment objectives, policy and strategy, the scheme property of the LTAF aims to provide a “prudent spread of risk”. This requirement matches the standard expected of a UCITS or NURS but is different to that of a QIS, which is only required to have a spread of risk.
Chapter 15 of COLL sets out permitted investments for the LTAF, which include specified investments, immovable assets and commodities, loans (subject to certain conditions), as well as collective investment schemes (CIS).
CIS investments may form an important part of the LTAF assets. The rules permit investment in both regulated and unregulated CIS, including limited partnerships. There is no requirement to ensure the underlying CIS does not invest more than 15 per cent in CIS, which is welcome and would therefore allow investment in funds of funds. There is however a principles-based approach requiring that the manager is comfortable that LTAF does not then invest back into itself. There are also rules relating to due diligence both initially and ongoing where the LTAF invests more than 20 per cent of the scheme property in unregulated CIS, QIS or other LTAFs.
The FCA has confirmed that investment in intermediate holding vehicles whether or not the vehicle is overseas is permitted.
Borrowing is permitted up to 30 per cent of the net asset value of the LTAF which is less than the 100 per cent allowed for QIS, but there are no rules on aggregate borrowing of underlying investments.
What are the rules on dealing and redemptions?
Given the nature of the LTAF assets the FCA has decided that the LTAF can redeem units no more often than monthly - daily dealing is not permitted. In addition, the rules require the LTAF to have a minimum notice period for redemptions of at least 90 days and in practice the FCA expects that many LTAFs will have significantly longer notice periods.
The period between dealing days will depend on the reasonable expectations of the target investor base and the particular objectives and policy of the LTAF.
In addition, the rules allow managers to use a range of liquidity management tools appropriate to investment in illiquid assets, provided that they are disclosed clearly to investors.
Permitted liquidity management tools
|Any liquidity management tools must be clearly disclosed in the prospectus (including worked examples of what they mean for investors in practice).|
The FCA is clear that an LTAF should not expect to use (nor rely on) suspension as a means of managing fund liquidity in the normal course of events. The FCA also expects the manager to be able to manage its liquidity so that it would not be forced to sell assets unexpectedly or over a time period when it could not achieve an appropriate value.
Ultimately, it will be for the manager to demonstrate to the FCA during the LTAF application for authorisation process that its suggested liquidity management tools are appropriate for the investment strategy of the LTAF.
What additional governance and disclosure rules apply?
The FCA has set additional oversight and governance requirements for the LTAF taking into account the risks which the LTAFs might be exposed to.
- Full scope AIFM with sufficient knowledge, skills and experience
Only a full scope alternative investment fund manager can be the manager of an LTAF.
The manager must possess the knowledge, skills and experience to understand the LTAF and risks involved in those activities and assets which the LTAF will hold, and employ sufficient personnel with relevant skills, knowledge and experience.
Where the manager delegates delegate portfolio management, the manager cannot rely on the delegate to meet this requirement. The manager will need to provide evidence in support of its credentials at the LTAF FCA authorisation stage and should expect a level of scrutiny in line with complexity of the asset class of the LTAF.
- Clear disclosures
In addition to strong governance, clear disclosure is a key aspect of the LTAF regime. Chapter 15 sets out the disclosure requirements for the LTAF in addition to the pre disclosure rules set out in FUND 3.2.
Specifically, certain prospectus disclosures must be set out fairly, clearly, and in plain language. The FCA notes that the LTAF may have complex features for example in relation to investment strategies, subscription and redemption terms and charging structures. Clear disclosures are considered important to give investors’ confidence that they can understand the nature of the investment and make an informed decision.
In relation to fees, the rules require fee disclosures equivalent to the requirements for UCITS and NURS (including to provide examples of how any performance fee will operate). The rules also require full disclosure of all costs and charges incurred (whether directly or indirectly) by the LTAF.
The prospectus will need to include disclosures on the due diligence process, as well as dealing and redemption, including liquidity management terms, together with worked examples to explain the effects or consequences of these features.
- External valuer the default position
The manager will be required to appoint an “external valuer”, unless it can demonstrate that it has the competence and experience to value the types of assets in which the LTAF invests.
Where the manager acts as the valuer, it will be required to value the LTAF’s assets in line with good industry practice. In a change to the draft rules, under the final rules the depositary will only be required to determine that the manager has the resources and procedures for carrying out a valuation of the assets. This reflects the requirements in FUND 3.11.25R(2) and FUND 3.9.
Valuations must be carried out monthly.
- Due diligence
The LTAF rules follow AIFMD requirements in relation to due diligence, requiring the manager to use good market practice when undertaking due diligence, to have effective arrangements in this regard and for these to be disclosed.
- Assessment of value and other aspects
The annual assessment of value requirement will apply to the manager of the LTAF involving the consideration of the matters set out in COLL 6.6.21R.
As the LTAF is an AIF, the manager will need to assess annually how it has managed the LTAF in the best interests of the LTAF, its investors, and the integrity of the market, pursuant to COBS 2.1.4. For the LTAF, when carrying out this assessment, the manager must consider as a minimum, how the assets have been valued, how the due diligence process has been conducted, how the manager has managed liquidity and conflicts of interest. The results of this assessment are to be included in the annual report of the LTAF.
- Quarterly reporting
The FCA rules require additional quarterly reports for investors, in addition to half-yearly and annual reports.
The FCA has decided against any additional governance requirements to those originally consulted on. The FCA notes in PS21/14 that if managers wish to have additional governance features, such as advisory boards, this is permitted but it is not mandatory and needs to be considered in light of investors’ needs and the costs of such features.
To whom can the LTAF be distributed?
The FCA considers that the principal target market for the LTAF are professional investors and in particular DC pension schemes, as well as sophisticated retail investors. Following consultation, the FCA has also amended the distribution rules to allow LTAFs to be promoted to certified high net worth individual investors. The LTAF is not considered suitable for unrestricted distribution to all retail investors.
Units in an LTAF are included in the definition of NMPIs (but not as originally consulted on in the definition of a qualified investor scheme (QIS)). This means the LTAF will be subject to the NMPI promotion rules meaning it can only be promoted to professional investors and only limited retail investors as set out in COBS 4.12, including certified sophisticated, self-certified sophisticated investors and certain high net worth investors.
Are they any outstanding issues?
The FCA has acknowledged in PS21/14 that the requirement applicable to authorised funds for the depositary to register the title to assets in its own name, rather than the name of the fund or the manager, is not practical for all eligible assets that an LTAF might invest in. The FCA has indicated that it plans to consult in the first half of 2022 on amending this requirement for the LTAF but also for other categories of fund not just the LTAF. This may well be helpful for managers interested in launching QIS funds. In the meantime, the FCA has suggested that where a firm wishes to launch an LTAF, the FCA will consider applications to waive the registration requirement in accordance with the relevant statutory tests.
As mentioned earlier, the FCA’s view is that the principal distribution market for the LTAF is professional investors and in particular DC pension schemes and with the LTAF being classified as an NMPI it can only be promoted to certain categories of retail investor. That said, the FCA has indicated that it is open to further discussion on the distribution of the LTAF and plans to consult in the first half of 2022 on potentially facilitating wider retail distribution.
Tax as ever is an important issue. An ACS structure for the LTAF could be attractive for tax exempt investors. The PAIF regime will also be available, as we believe would be the TEF regime, but these regimes are operationally quite complex. The FCA notes in PS21/14 that it has been working closely with Treasury and HMRC throughout the development of the LTAF, and that the Government will ensure that pre-existing tax legislation in relation to PAIFs and ACS continues to operate effectively for these regimes.
Does the LTAF have special tax treatment?
Certain authorised funds are required to meet the genuine diversity of ownership (GDO) condition in order to access the beneficial tax treatment applicable to authorised investment funds. This is also the case for the LTAF however additional provisions have been included for the LTAF.
Pursuant to these additional provisions, the LTAF will be treated as meeting the GDO condition where at least 70 per cent of the units or shares in the LTAF are held by one or more "relevant investors", or by the manager of the fund in their capacity as manager.
Broadly, "relevant investors" are defined as:
An authorised unit trust scheme (or overseas equivalent) which meets the GDO condition
An open-ended investment company (or overseas equivalent) which meets the GDO condition
A UK or foreign regulated insurer which is not a close company
A sovereign wealth fund
The trustee, manager or administrator of a pension scheme, including a local government pension scheme (other than an "investment regulated pension scheme").
An “investment regulated pension scheme, is in summary, a SIPP or SSAS scheme. This means that although such schemes can invest in an LTAF, unless other investors qualify for the 70 per cent provision, the standard GDO condition needs to be satisfied.
It is also possible to apply in writing for a clearance from HMRC that a fund, including the LTAF, meets or is treated as meeting the GDO.
A new authorised fund type with appropriate features and safeguards for investment in long-term illiquid assets is a welcome development.
The LTAF will appeal to investors looking for exposure to long term. Illiquid assets, with a long-term horizon and appropriate risk appetite but who also want the additional oversight and governance of an FCA authorised fund. The LTAF is therefore likely to be of interest to DC pension schemes but also potentially to larger charities and not for profit organisations who often have a longer-term investment horizon. There is also the possibility, expressly permitted in the rules, to have an LTAF charity authorised investment fund (CAIF). With the benefit of the favourable tax treatment of the CAIF, and the ability to hold over income from one accounting period to another, this structure could be very interesting, but given the limits on distribution, at the moment the investor base would be limited to large and sophisticated charities. See our earlier briefing on CAIFs here.
Given the concerns around fund liquidity highlighted by the Woodford case, it is not surprising that the FCA is proceeding with caution regarding retail investment in the LTAF. Helpfully, the FCA has said it is open to explore a possible wider distribution, and it is welcome that both sophisticated and certified high net worth investors will be able to invest in the LTAF.
As with any new type of FCA authorised fund, the first LTAFs to be approved whilst having first mover advantage will also be the testing ground for this new type of fund. The IA is forming an implementation forum for managers, service providers and advisers who are interested in launching an LTAF.
If you require further information about anything covered in this briefing, please contact Grania Baird or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, October 2021